Islamic Banks are Relatively Inefficient in Containing Costs

Written By Dinda Revolusi on Senin, 21 Februari 2011 | 17.50

This paper investigates relative efficiency of the Islamic banking industry in the world by analyzing a panel of banks during the period of 1995-2001. Both parametric (cost and profit efficiency) and nonparametric (data envelopment analysis) techniques are used to examine efficiency of these banks. Five DEA efficiency measures such as cost, allocative, technical, pure technical and scale efficiency scores are calculated and correlated with conventional accounting measures of performance. The results indicate that, on average, the Islamic banking industry is relatively less efficient compared to their conventional counterparts in other parts of the world. The results also show that these efficiency measures are highly correlated with ROA and ROE, suggesting that the efficiency measures can be used concurrently with conventional accounting ratios in determining Islamic bank performance.

The average cost efficiency (stochastic cost frontier) is 73.5%, whereas the average profit efficiency (profit efficiency frontier) is 84.4%. Although Islamic banks are relatively inefficient in containing costs, they are relatively efficient in generating profit. The average allocative efficiency is 73.3%, whereas the average technical efficiency is approximately 84.3%. This means that the dominant source of inefficiency is due to allocative inefficiency rather than technical inefficiency. These results are consistent with the fact that Islamic banks operate in overall regulatory environments that are not very supportive of their operations.

Hassan (2003b) found that when Islamic banks operate in countries such as Iran and Sudan, where the entire banking system operates under Islamic Shariah, the banks become more allocatively efficient. Average scale efficiency is approximately 89.1%, and average pure technical efficiency is approximately 95%, suggesting that the major source of the total technical inefficiency for Islamic banks is not pure technical inefficiency (input related) but scale inefficiency (output related).

Our results indicate that there have been moderate increases in productivity growth over the years. Productivity increases in the Islamic banking industry is mainly driven by technological change (opening up and penetrating other markets) not technical efficiency change (efforts of inefficient banks to catch up with those that are efficient). The results indicate that larger bank size is associated with higher scale efficiency. These results indirectly support the economies of scale arguments in the Islamic banking industry.

Most of the Islamic banks are of smaller size compared to their conventional counterparts. It is imperative that Islamic banks be allowed to merge to obtain an optimal size in order to become more technically efficient and compete with their conventional counterparts. Multinational conventional banks which engage in Islamic banking have a size advantage over smaller Islamic banks. The only way for Islamic banks to be competitive with multinationals is to bring products and services in conformity with the true spirit of Islamic prohibition of interest, utilize modern technology and expand the score and scale of their operations.

The information obtained from efficiency studies can be used to help bank managers, government regulators and investors. Managerial performance can be improved by identifying “best practice” and “worst practice” associated with high and low efficiency firms, respectively. In addition, success in competitive markets demands achieving the highest levels of performance through continuous improvement and learning. Finally, frontier efficiency analyses can identify best practice banks and provide numerical efficiency scores and rankings which can be quite useful to policy makers, market analysts, and managers of competing banks.

0 komentar:

Posting Komentar